CVS 2007 Annual Report Download - page 31

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27 I 2007 Annual Report
pharmacies, customer service operations and related information
technology support. Gross profit as a percentage of revenues
was 8.6% in 2007. This compares to 12.4% in 2006 and 11.7%
in 2005.
During 2007, the Caremark Merger significantly affected our
gross profit. As you review our Pharmacy Services Segment’s
performance in this area, we believe you should consider the
following important information:
• As discussed above, our national retail network contracts are
reviewed on an individual basis to determine if the revenues
should be accounted for using the gross or net method under
applicable accounting rules. Under these rules the majority of
Caremark’s national retail network contracts are accounted for
using the gross method, resulting in increased revenues,
increased cost of revenues and lower gross profit rates. The
conversion of PharmaCare contracts to the Caremark contract
structure, effective September 2007, also resulted in increased
revenues, increased cost of revenues and lower gross profit
margins. The change in revenue recognition had no impact on
the actual gross profit amount.
• During 2007, on a comparable basis, our gross profit as a
percentage of total net revenues was 8.2%. This compares to
the gross profit as a percentage of total net revenues of 7.0%
in 2006.
• During 2007, on a comparable basis, our gross profit rate
benefited from a portion of the significant purchasing synergies
resulting from the Caremark Merger. We expect the benefit
from purchasing synergies to continue to positively impact our
pharmacy gross profit rate through fiscal 2008.
• During 2007, on a comparable basis, our gross profit rate
benefited from an increase in our generic dispensing rates.
Total generic dispensing rates increased to 60.1% in 2007,
compared to 55.8% in 2006. As previously discussed, our
net revenues are reduced as generic dispensing rates increase,
however, our gross profit and gross profit margins generally
increase with the corresponding increase in generic dispensing
rates. However, the increased use of generic drugs is increasing
the pressure from clients to reduce pharmacy reimbursement
payments for generic drugs.
in 2007, compared to 57.4% in 2006. The 430 basis point
increase in generic dispensing rate was comparable to that in
our mail service claims and is attributable to the same industry
dynamics. We anticipate that our generic dispensing rates
will increase in future periods, however, the magnitude of the
increases will be determined by new generic drug introductions
and our efforts to encourage plan participants to utilize generic
drugs when available.
• During 2007, net revenues benefited from our participation in
the administration of the Medicare Part D Drug Benefit through
the provision of PBM services to our health plan clients and
other clients that have qualified as a Medicare Part D Prescription
Drug Plan (“PDP”). We also participate (i) by offering Medicare
Part D benefits through our subsidiary, SilverScript, which has
been approved by CMS as a PDP in all regions of the country
and (ii), by assisting employer, union and other health plan
clients that qualify for the retiree drug subsidy available under
Medicare Part D by collecting and submitting eligibility and/or
drug cost data to CMS for them as required under Part D in
order to obtain the subsidy and (iii) through a joint venture with
Universal American Financial Corp. (“UAFC”), which sponsors
Prescription Pathways, an approved PDP.
Both SilverScript and Prescription Pathways were in the top
ten PDPs in the country in terms of enrollment during 2007.
Revenues related to SilverScript and our joint venture with
UAFC are comparable between 2007 and 2006. The majority
of these revenues are included in our retail network revenue
due to the high level of retail network utilization within the
Medicare Part D program.
In February 2008, the Company and UAFC agreed to dissolve
this joint venture at the end of the 2008 plan year and to
divide responsibility for providing Medicare Part D services to
the affected Prescription Pathways plan members beginning
with the 2009 plan year. The terms of this agreement are
subject to regulatory approval.
Gross profit includes net revenues less cost of revenues. Cost of
revenues includes the cost of pharmaceuticals dispensed, either
directly through our mail service and specialty retail pharmacies or
indirectly through our national retail pharmacy network, shipping
and handling costs and the operating costs of our mail service